What Can CEOs Learn From Activist Investors?

Although activist investors are often a source of worry for executives, there are a number of positive effects that they can bring to a company.

During an interview with McKinsey global managing director Dominic Barton, company principal Tim Koller discusses what CEOs can learn from activist investors and the benefits that they can bring.

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Koller emphasizes the need for a nuanced assessment of activist investors

The first point made by Barton is that there are activists that have different goals, and thus “it’s not necessarily helpful to lump them altogether.” While some are looking to turn a short-term profit, others will stick around for a while and work with management.

Those who hold on to their investments can be good board members because “they add a lot of value, they’re well prepared, they ask good questions, they do research,” said Koller.

Activists that are thinking of long-term profits can actually come in and shake up management systems in a company that may have become less proactive or aggressive.

How can CEOs think like activists?

CEOs that feel threatened by activist investors would do well to try and get inside their minds and work out what they are thinking. Koller warns that there isn’t much that a board of directors can do to make their company safe from the negative influences of some activists, but by thinking like them they can try to head off their influence.

Management needs to ensure that it is assessing itself as an activist would in order to evaluate its performance. “Am I the best owner of the businesses? Am I growing the businesses adequately? Am I cutting costs where they need to be cut? Am I returning cash to shareholders when I don’t need it? So it’s much more a matter of doing it yourself,” said Koller.

Different businesses should be assessed with respect to their specific conditions

Discussion then turns to the release of the sixth edition of the Valuation book, of which Koller is a coauthor. Although the fundamental principles remain the same as when the book was first published 25 years ago, there is a new emphasis on understanding how companies can create value.

Koller says that businesses “create value by earning an adequate return on capital and growing their business. Getting the right combinations of growth and return on capital is what ultimately is going to drive the cash flows of a company and drive value.”

The book also encourages management to look at different business units, splitting divisions into layers in order to recognize growth opportunities. Koller says that this granular approach is more necessary now than ever before. It’s “not that the principles changed but the context changed,” he says.

Koller puts the developments down to increased competition, but points out that the situation also changes according to the sector. Clearly, things move very quickly in the tech sector, for example. In other sectors, it may be other forces that are driving it. There may be sectors that are simply declining because consumers don’t need as much of those products,” he said.

Consequently there are huge variations in returns on capital and growth rates across different sectors, and it is down to companies to work out what course of action best fits their specific case. Koller maintains that there is no general answer, and the focus should be on “what’s right for you given your return on capital, given your competitive environment, given the growth opportunities.”